Cross border flows, with a bit of macroeconomics

Chastened prophets of doom

In a recent talk at the Council on Foreign Relations, former US Treasury Secretary Larry Summers described himself as a “chastened prophet”– a description that former Chairman of the Fed Paul Volcker also embraced. Both warned about the risks associated with large US current account deficits several years ago.

I lack the stature of Summers and Volcker, but I too often feel like a “chastened prophet of doom.” Along with Dr. Roubini, I publicly worried in 2004 that a $600b US current account deficit financed in large part by demand for US debt from the world’s central bank carried grave risks. It is hard to be less worried by a $800-900b current account deficit if anything now financed in even larger measure by demand for US debt from the world’s central banks.

Especially a deficit that doesn’t seem to be falling when global conditions are about as good – setting aside the dollar’s inability to fall v. many in Asia and high oil prices – for a benign adjustment as is likely to be case for some time.

Yet, as Summers noted in his talk, the “balance of terror” generated a relatively stable state system during the cold war, as – at least– so far, has the “balance of financial terror”.

Dooley, Garber and Folkerts-Landau’s core argument back in 2003 – that reserve accumulation in the emerging world finance large current account deficits in the center at low cost – has stood the test of time.

The best their critics can claim is that some of the contradictions in the Bretton Woods system are still playing themselves out, just at a slower pace than their critics – myself included – initially expected. Protectionism in the center and inflation in the periphery are more visible now than they have been previously.

Still, I never imagined that China would add over $40b to its reserves a month in a quarter – and might sustain that pace (close to $500b annualized) for an entire year. That is an extraordinary number. I never imagined that the Gulf countries – given all that has happened in the Middle East – would be as willing as they seem to have been to lend a large share of the oil windfall to the US (60%?). If the most Kuwait is willing to do is to reduce the dollar’s share in its basket to 80%, I am not sure that changes much.

I never imagined that Russia might be on track to add $30b (if not more) to its reserves in a single month. I certainly never imagined that Brazil would stop releasing high-frequency data about its reserves because of worries that its reserves are growing too quickly, not because of worries that it was close to running out of foreign exchange. Behind the wall of secrecy, Brazil probably is on track to add $20b to its reserves this month – though some of the accumulation may be “off balance sheet.”

Those are phenomenal numbers. In the first quarter, Christian Menegatti and I estimate that central bank reserve accumulation reached $100b a month. That is more than enough to finance the US current account deficit. And if anything, the global pace of reserve growth looks to have picked up in April and May. While India's central bank stepped back and let the rupee appreciate, other central banks did not.

It is hard to argue that Bretton Woods 2 (the financial coalition of the willing?) isn't still going strong. Maybe a bit too strong.

60 Comments

Posted by Rick45May 27, 2007 at 3:03 am

“About protectionism. I don’t think that there will be much push for protectionism. Workers whose jobs are in the process of being moved overseas will complain loudly about free trade. Workers whose jobs have already been moved overseas don’t exist at all to complain. I think we are fast reaching the point that the industries that would have complained about the loss of jobs are already disappeared completely.”

TwoFish are you not forgeting the innocent victims of lost jobs/industry? Example, the single mother of 5 in any one of a medium-sized urban-center in the Midwest. She “pushes” paper for the state or other entity and works hard to stay above water. The house she bought 6 years ago has in real-terms appreciated little in value if at all. When the scapegoat of illegal immigration runs it’s course who is next, crooks in silk suits that continue to support the Ponzi Scheme of B.W.II? Or need I remind you that we have a general election coming-soon. Desperate people will produce atleast one black swan, for example a “populist-spiritual leader” thrusted into the White House!

Posted by RebelEconomistMay 27, 2007 at 4:52 am

Anonymous,

I am not exactly sure what you are asking, but I will endeavour to address the issue I think you raise.

I presume that the proceeds of a tariff on Chinese imports would go to the US government and hence Americans in general. The cost of the tariff to China-based producers will depend on the extent to which they are able to maintain their pre-tariff price in the face of the price of their product in the US market, but the producer cost of the tariff will certainly be non-negative. American-owned Chinese producers may, however, benefit if the tariff revenue was used to, for example, lower corporate taxes, and it is conceivable that this could more than offset the cost of the tariff, in which case it would effectively subsidise them. American-based, American-owned producers would have the advantage of both a relative price change (in the American market) in their favour and any tax cuts.

Of course, all of this only considers the immediate impact of the tariff and how the US government uses it. Assuming that Chinese exchange rate policy does indeed mean an undervalued yuan, the policy subsidises American consumer borrowers as well as Chinese producers, so they would lose out if the tariff reduced Chinese intervention. And then there are the effects of Chinese retaliation and any spreading of trade barriers to consider.

Posted by GuestMay 27, 2007 at 7:36 am

“…Sotheby’s set a record total for a contemporary art auction this month, raising $254.9m in one night… But within 24 hours that figure was smashed by Christie’s, its rival, with a $384.7m buying binge… One way of looking at high art prices is as part of a global wave of liquidity that is pushing up asset prices everywhere… A variant of the same argument is that high art prices reflect the increasing number of rich people from all parts of the world. Russian and Chinese millionaires, along with hedge-fund and private-equity managers… But the founders of the Art Trading Fund reckon art prices are well below their peak in the late 1980s, when adjusted for inflation…” http://economist.com/finance/displaystory.cfm?story_id=9231869

“…Morgan Stanley estimated in March that the total funds at the disposal of SWFs may be as high as $2,500bn (£1,157bn, â‚¬1,710bn), already around half the gross official reserves of all countries. By comparison, the global hedge fund industry is thought to manage about $1,500bn to $2,000bn of assets, some of which may include existing SWF money… “China Inc’s investment decisions are going to have the capacity to move markets for a long time,” says Brad Setser of Roubini Global Economics. But the SWF story is more than just China…

Analysts say the evolution from official reserves to SWFs should be positive for emerging market assets and positive for risky assets in general. A wholesale move from bonds to equities by the world’s central banks should also boost the yen. Only 3.2 per cent of the world’s total official reserves are held in yen. However, global equity managers typically hold a greater percentage of their portfolios in the currency… If SWFs invest funds in equities in line with Japan’s global weighting, they will have proportionally more money in yen assets than they would have if they kept funds in traditional reserves…

Some of the newer SWFs appear to be following a similar path to the Abu Dhabi Investment Authority… But there are few public details on its operations, with no official figures released for Adia’s investments. Morgan Stanley estimates it is the world’s largest SWF, managing as much as $875bn. But where this money is deployed is a matter of conjecture…”

while initial studies re. Germany date back nearly a century, more recent seem to indicate that a protectionist tariff hike can lead not only to tariff jumping but also relatively higher profit rates for those firms already on both sides of the politically erected ‘barrier’. Which is also to say that rather than enhancing domestic firms, the contrary can take place. Certainly though degrees of sectoral concentration need also be taken into account.

Posted by GuestMay 28, 2007 at 5:34 am

“…The effect of cheaper manufactured goods in the west has started to wane just as rapid growth in India and China has pushed up the cost of commodities, feeding into the cost of living…” http://business.guardian.co.uk/story/0,,2089382,00.html

Posted by GuestMay 28, 2007 at 5:40 am

“…Authorities blame IPOs and enormous borrowings in the West by state and private firms for higher than expected capital inflows, which put additional pressure on the government’s inflation targets… the Central Bank, which has only weak monetary policy instruments, is forced to allow the value of the ruble to appreciate. That in turn erodes the competitiveness of Russia’s key export-oriented industries… The country’s booming economy is giving Kudrin another headache: how to spend it. The government has amassed more than $113 billion of windfall oil revenues in the stabilization fund… President Vladimir Putin last Monday suggested some of the money could go to support Russian stock markets, but backtracked three days later, saying there were no plans to do so.” http://www.moscowtimes.ru/stories/2007/05/28/047.html

Posted by josh bivensJune 1, 2007 at 9:32 am

brad

i haven’t been able to check this site as often as i like recently, so, i’m sure you’ve written on this before, but, what *are* the GCC countries trying to do with all their dollar purchases?

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